Bridge loans are a type of short-term borrowing where an owner of a property borrows money against the equity of that property. Ideally, when selling your home, the money you receive can help fund your new home, but since the timing and logistics of this do not always work out, a bridge loan can exist to “bridge” that financial gap. Such a loan intends to allow people to use the equity of their current property to finance the downpayment on a new one. It seems like a great deal, but it has some factors which may make them not as appealing. Let’s review some pros and cons of bridge loans.
Advantages of a Bridge Loan:
● Advantageous for Sellers. When a seller and a buyer agree on a property sale, most of the time, the purchase of the property is contingent upon the sale of the buyer’s property. What this means is that if the buyers are selling their home, and agree on a sale, if the buyer cannot sell their property, they may back out of the agreed-upon transaction as they are counting on the money from their sale for the down payment. A bridge loan helps in this regard as it allows the buyers to have down payment funds and not have their purchase stifled by delays or the falling through of their own property’s sale.
● Faster process. The acquisition of a bridge loan is typically a quicker process than that of a traditional loan, which allows the loan recipient to have the funds he or she needs in their hands faster to utilize for their desired uses.
● Payment Grace Period. Most bridge loans allow a grace period before payment would need to begin getting made. Most short term loans can wait as long as 3-5 months before the payments start. If you purchase with a bridge loan, it may not require payments until you complete the purchase.
Disadvantages Of A Bridge Loan
● Higher interest. Because bridge loans are a short term loan, you pay the interest over a shorter period. While the actual interest is often small compared to other types of loans, the rate will be much higher. If you have bad credit, the amount you pay could be up to 10% of the loan value. They aren’t predatory like a payday loan, but you must be careful to make sure you’re able to pay it off.
● Increases total debt. At best, if your property sells, you will have higher liability than you started with as you repay the bridge loan alongside the payments for your new property. Additionally, getting a bridge loan would likely increase your debt to income ratio. If your debt surpasses your income, you may not be able to even qualify for a loan on a new property, so care should be taken that the bridge loan does not ruin your chances of landing a new property.
● Double mortgage. If you used a bridge loan to acquire a new property, but still own your current property (not sold yet), you will now be on the hook for your current property payments, your new property, and the repayment of your bridge loan. If you use the bridge loan to purchase a new property, and then your sale falls through, you would be stuck with two simultaneous mortgages.